METI-RIETI Symposium

Corporate Governance Reform in Japan: Lessons from the United Kingdom (Summary)

Information

Summary

Opening Remarks

  • MIYAJIMA Hideaki (Faculty Fellow, RIETI / Professor, Faculty of Commerce, Waseda University / Director, Waseda Institute for Advanced Study)

Governance structural reform is currently receiving attention as part of Abenomics in relation to economic growth. Following the publication of the Stewardship Code and the revision of the Companies Act, a Japanese corporate governance code is now being formulated. In considering corporate governance structural reforms in Japan, the United Kingdom's experience will serve as a very informative reference. Against this backdrop, as Professor Colin Mayer of Saïd Business School, University of Oxford, was visiting Japan, we planned this symposium to consider what lessons we can learn in relation to Japan's governance structural reforms. In his book Firm Commitment published last year, Professor Mayer discussed a new corporate theory based on the concept of commitment. Based on this, his lecture will provide us with suggestions about governance structural reforms in Japan.

Corporate Governance Reform in Japan: Lessons from the UK, US, and Elsewhere

  • Colin MAYER (Peter Moores Professor of Management Studies, Saïd Business School, University of Oxford)

After the recent financial crisis, calls were made for fundamental changes to corporate governance in companies around the world. I will talk about the traditional view of corporate governance; the global, UK, European, and U.S. experience; and developments in, lessons of, and conclusions for possible direction for reform in Japan. My conclusions are that corporate governance is critical for corporate performance; that it is more than just corporate boards; and that it is about ownership, commitment to parties in the firm, and the control of them. Although regulation can promote governance, excess regulation can have adverse effects. There has been an increase in international shareholding in Japan that has positively affected company performance, and Japan should maintain stable shareholdings and promote outside ownership by defining board responsibilities.

The traditional view holds that corporate governance is about improving performance for shareholders, and that the board of directors has a responsibility to maximize the value of the company. This is reflected in policy recommendations on corporate governance rules, stewardship codes, stock market listing rules, and takeover codes.

Part 1: The Global Experience

In response to the Asian Financial Crisis, the International Monetary Fund (IMF) and the U.S. Department of the Treasury made recommendations for reform. The crisis was blamed on "crony capitalism" (the high number of family- and state-controlled businesses) and cross-shareholdings in Japan. The dispersed ownership structures of the United States and the United Kingdom were recommended. Fortunately, this dubious advice was not followed. Indeed, the United States experienced the dot-com bubble and accounting scandals which lead to stronger corporate governance standards, improved accounting rules, and the Sarbanes-Oxley Act.

The global financial crisis showed that standard views of corporate governance were incorrect. Companies with the best corporate governance failed the most. Corporate governance should focus instead on promoting economic prosperity, entrepreneurship, innovation, growth, value creation, and the creation of a fair society. Corporate governance is also concerned with ownership, control, and the provision of commitments by companies to different parties.

Part 2: The UK Experience

The Cadbury Committee of 1992 brought the notion of "comply or explain," meaning that rules should be created but that companies can deviate, which lead first to the UK's Corporate Governance Code and then the Stewardship Code. The Stewardship Code makes recommendations targeting institutional investors. In addition, stock market listing rules that relate to all companies were created, along with the Takeover Code. Dual class shares cannot be issued on the London Stock Exchange, and takeover defenses are not allowed. The Corporate Governance Code creates rules for leadership, expectations for the board, rules on accountability, rules on remuneration, and good communication with shareholders. The Stewardship Code provides recommendations for stewardship policy, avoiding conflicts of interest, monitoring, intervention, collective action, voting, and reporting.

Although these codes provide detailed guidance for the companies and their owners, the stock market in the United Kingdom is disappearing. There were 2,194 firms listed on the London Stock Exchange in 1999, but this numbered 932 in 2014. The number of listed companies in the United States has dropped by 38% since 1997. Ownership has changed; since 1989, pension funds and insurance companies have owned 49.2% of British equity, but this fell to 13.7% in 2010. Over the same time period, individual ownership dropped from 20.6% to 11.5%, while the percentage owned by foreign investors and other financial institutions increased from 13.9% to 57.2%.

Although the takeover market is viewed as discipline for failing companies, corporate control for the United Kingdom and around the world has disappeared. Henry Manne said, "New scandals will continue until we bring back the most powerful market mechanism for displacing bad managers: hostile takeovers." Although hostile takeovers may have never been disciplinary, they have nearly stopped. Short-term investment has become the norm, with the average amount of time that an investment is held falling from eight years 70 years ago, to three years 40 years ago, and to a matter of months today. There is greater pressure for short-term performance in the United Kingdom than ever before. Investors have failed to commit to the long-term prosperity of companies, leading to problems. My point is that "model" corporate governance can lead to detrimental changes in the financial system.

One cause of the eclipse of the public corporation is excessive investor protection and the dispersed nature of shareholders. This prevents shareholders from exercising control, leading to an "ownerless" economy, as no shareholder is strong enough for effective corporate governance.

Part 3: The European Experience

In contrast to the United Kingdom, most European companies are not listed and have a single majority shareholder (usually a family), which lead to stable ownership. In Germany, Italy, and France, from 1996 to 2006, there was no change in control at the majority of companies. This is not the case in the United Kingdom where short-term shareholdings reign.

Part 4: The U.S. Experience

Although the United Kingdom differs from continental Europe, it also differs from the United States. In the United States, there are more holders of large blocks of shares as compared to the United Kingdom. The United States also has many more protections against hostile takeovers. When Google Inc. went public, founders and executives were issued class B shares with 10 times the number of votes. Companies with this dual class share system perform better, and the courts have upheld the "poison pill" approach to preventing takeovers. Although these features are viewed as undesirable, they can protect management from shareholders and allow them to take a long-term view of the company. However, dual class shares and takeover protections are systematically prohibited in the UK system.

Part 5: The Lessons

The correct focus of corporate governance is on structuring firms to achieve the right balance of commitment and control to attain objectives and on promoting entrepreneurship, innovation, and corporate flourishing in a fair and just society.

Nearly 20 years ago, a survey of middle managers from five countries asked whether the companies were being run in the interest of shareholders or of stakeholders. In the United Kingdom and the United States, 70% showed a focus on shareholders, while in Germany and France, it was 20%, and in Japan, it was 3%. The same survey asked if dividends or payrolls would be cut during financial difficulties. 90% of U.S. and UK companies said they would cut payrolls, while that for France and Germany was 40%, and that for Japan was 3%. This elicits high employee, supplier, and purchaser loyalty in Germany, France, and Japan, but it leaves companies exposed to expropriation by those stakeholders, while those in the United States and the United Kingdom are exposed to the shareholders. A balance is needed between commitment to stakeholders and control by owners, but this should be decided by each company.

Part 6: Recent Developments in Japan

In most Asian countries, companies are not widely held and most are owned by families or, in China, by the state. However, family ownership in Japan is small, looking more similar to the United States or the United Kingdom. Companies in Japan own other companies' shares in a cross-shareholding relationship. After the banking crisis in Japan, patterns shifted with more outside and foreign ownership by institutional shareholders, but cross-shareholdings by companies have not changed. Foreign ownership has increased much more at large Japanese companies, while insider ownership has decreased. Unlike the UK collapse of the stock market, the number of listed companies in Japan has not changed, while cross-shareholding maintains a stable core.

Current research is attempting to show that foreign ownership improves corporate governance and stock market value, as shown by the performance of Japanese companies. One issue is how to encourage foreign investment and protect them from an insider-dominated system while protecting stable core ownership. Without this core, the Japanese system would be like the dispersed UK system. Again, a balance is required between shareholder protection and stakeholder profession. I believe it is possible to strike this proper balance through regulation.

Indeed, the same suggestions for the United Kingdom are even more applicable in Japan, particularly in protecting outsider shareholders from the insiders. However, Japan should not go as far as where shareholders cannot exercise control. Further strengthening of Japan's investor protection rules would promote uniformity rather than the needed diversity of governance structures. A two-tier board structure with management and supervisory boards would assist in maintaining a balance between stakeholders and shareholders, especially if interests differ between inside and outside shareholders. However, sometimes a unitary board system is more effective, as long as the board has a common purpose agreed upon by the stakeholders. This system retains the beneficial Japanese system focused on long-term performance. It also protects outside shareholders and allows them to be tapped for investment, while maintaining strong ownership balanced with monitoring by outside shareholders.

In summary, corporate governance is more than promoting shareholder interests. It is about promoting growth, investment, efficiency, and fairness. A balance between the control of companies and the commitment given to stakeholders must be found. Excessive investor protection risks imposing uniformity, whereas diversity is created by allowing companies to find their own balance. Japan is moving from an insider-dominated system to a hybrid system that may bring significant benefits if the interests of both inside and outside shareholders are maintained.

Panel Discussion & QA

Moderator:

  • MIYAJIMA Hideaki (Faculty Fellow, RIETI / Professor, Faculty of Commerce, Waseda University / Director, Waseda Institute for Advanced Study)

Panelists:

  • Colin MAYER (Peter Moores Professor of Management Studies, Saïd Business School, University of Oxford)
  • ITO Akihiro (CFO, Member of the Board of Kirin Holdings Company, Limited)
  • OBA Akiyoshi (President & CEO, Tokio Marine Asset Management Co., Ltd. / Member of the Corporate Governance System Study Group, METI)
  • SHISHIDO Zenichi (Professor, Graduate School of International Corporate Strategy, Hitotsubashi University)

Presentation

  • SHISHIDO Zenichi (Professor, Graduate School of International Corporate Strategy, Hitotsubashi University)

Professor Mayer suggests that companies that implement governance toward maximization of not only shareholders' interest but also stakeholders' interest are trusted firms and criticizes UK and U.S. companies' excessive emphasis on the maximization of shareholders' interest. In this sense, most Japanese companies are trusted companies. Japanese companies are required by the Companies Act and various guidelines to maximize their corporate value, which enable business managers to put weight on stakeholders' interest. On the other hand, it is pointed out that, in Japan, shareholders' interest is underappreciated and monitoring by external shareholders is weak. In order to achieve a balance, I hope traditional institutional investors will assume the role of being a catalyst in influencing business managers, and activist investors will play a supplementary role, such as identifying issues. Furthermore, regulations of the board of directors should be provided with enough flexibility for the company to select an optimal board structure considering its characteristics.

  • OBA Akiyoshi (President & CEO, Tokio Marine Asset Management Co., Ltd. / Member of the Corporate Governance System Study Group, METI)

One of the governance issues at Japanese companies presently discussed is "earning power." Japan is the only stock market in the world that has been sluggish for 30 years. The government's Japan Revitalization Strategy (Revised 2014) also emphasizes the need to reinforce corporate governance to regain "earning power." Stakeholders to whom Japanese companies pay primary attention are employees, customers, and banks, and investors are in fact placed in a relatively inferior position. Japanese companies should strive to maintain a balance among these four stakeholders and create a society where they will be able to achieve sustainable growth. Meanwhile, there are some 200 companies that have provided investors with positive returns over the 30 years. They are mainly companies managed by owners. There might be correlations between ownership and stock price performance.

  • ITO Akihiro (CFO, Member of the Board of Kirin Holdings Company, Limited)

Kirin Holdings' board of directors is comprised of five internal directors and two outside directors. Recently, we set up an International Advisory Board that serves as a consultative body for the CEO, which includes members with global management experience. Also, we have launched an asset liquidation project as an approach to raising funds for our M&A strategy. As part of the project, we started to unravel part of our cross-shareholdings, decreasing the percentage of cross shareholdings to below 20% of the total number of outstanding shares. Investor relations (IR) functions should serve as opportunities for both companies and investors to recognize issues from the perspective of achieving medium- and long-term growth. I would like to suggest that disclosure of corporate earnings forecasts should be reconsidered now in the context of growth strategy and global standard.

Discussion

MIYAJIMA Hideaki
Professor Mayer, could you give us some general comments or a reply to the previous speakers.

Colin MAYER
Professors Shishido and Oba essentially agreed with my presentation. Corporate governance is about striking a balance between different parties. Japan is too focused on stakeholders, while the United States and the United Kingdom are too focused on shareholders. Professor Shishido suggested that hedge funds help strike a balance in Japan, but it is difficult for them to do business. Also, western-style monitoring boards support rather than monitor management. If a conflict arises, management loses trust in the board. Mr. Ito mentioned how Japanese companies are rebalancing by focusing on shareholders and long term prosperity. Governance structures and the role of non-executives and boards are vital.

MIYAJIMA Hideaki
Who should monitor companies and their governance structures to strengthen the role of investors in Japan?

Colin MAYER
Successful companies are monitored by dominant long-term shareholders. They determine the company's purpose, values, balance between stakeholders, and intervene when problems arise. External shareholders are important to dominant shareholders because they provide capital and influence stock price.

MIYAJIMA Hideaki
Considering the unique Japanese business environment, how well can foreign investors act as monitors?

Colin MAYER
Foreign investors are not committed and will exit if the Japanese market sours. They indicate whether their interests are being upheld, but they do not have control. In the United Kingdom, foreign investors exert control, leading to short-termism. There needs to be a balance.

MIYAJIMA Hideaki
In Japan, short term investors do not have much influence, whereas domestic institutional investors might be able to exert influence. Does this happen in the United Kingdom?

Colin MAYER
This does not happen. Institutional investors have handed control over to fund managers that are only interested in quarter to quarter returns. Returns in Japan are low, but the structure is stable and moving toward the interests of outside shareholders. This is good. For the United Kingdom, returning control to committed long-term institutional investors is extremely difficult.

SHISHIDO Zenichi
In the past, cross-shareholding practices limited returns and excluded external shareholders from corporate governance. Institutional investors, who have turned out to be influential, might monitor Japanese companies without taking into account the uniqueness of each Japanese company. This is a concern.

MIYAJIMA Hideaki
A kind of cross-holding occurs where companies agree not to sell each other's stocks, resulting in low stock prices. How can companies in this situation be properly controlled/regulated?

Colin MAYER
Corporations exist to promote economic activity and growth, not just to increase stock prices. Japanese companies used to focus on cross-shareholders, but the banking crisis caused companies to seek finance from the stock market. This created a positive situation where boards rebalanced towards stockholders. A two-tier board system would benefit some Japanese companies that have a divisive board lacking a unified vision.

MIYAJIMA Hideaki
Would shareholder voting rights and dual-class shares be successful in Japan?

Colin MAYER
Japan needs entrepreneurship, and dual class shares encourage it by allowing founders to maintain control. Old firms should not have dual class shares because insider shareholders would gain more control.

MIYAJIMA Hideaki
Japan introduces a principle of "comply or explain" that suggests that outside directors should be part of a company's board. What form of corporate governance arrangement would be appropriate for shifting control to outside shareholders while maintaining the positive aspects of Japanese corporations? Regarding two-tier boards, who should sit on the supervisory board?

Colin MAYER
"Comply or explain" is successful because it is a set of recommendations rather than laws. However, this is not successful in the United Kingdom because everyone complies to appease shareholders. In Japan, where shareholders are not as strong, "comply or explain" is beneficial. When insider shareholders have control, a unitary board structure is preferable as long as employees and outside shareholders are being looked after. A dual-tier board system is effective if conflicts exist in a unitary board. However, companies with a national interest such as utilities or systemically important banks benefit from a trust board that upholds public and shareholder interest.

MIYAJIMA Hideaki
Let us take questions from the floor.

Q1. What is your assessment of corporate governance under Abenomics?

OBA Akiyoshi
The reforms will have a slow impact on stock prices, but they will be effective in the long run. The Japanese version of the Stewardship Code should create a desirable company-investor relationship. Good governance is also required to be included in the new JPX-Nikkei Index 400.

SHISHIDO Zenichi
There should not be too much regulation, and the "comply or explain" reforms in Japan can support long-term growth because companies will take outside views into consideration.

ITO Akihiro
The focus on shareholders in Japan has increased over the past five years. Outside directors in Japanese companies must focus on improving long-term growth.

Q2. Does the disappearance of listed companies in the United Kingdom and the United States negatively affect unlisted companies?

Colin MAYER
Perhaps a decrease in listed companies is good because private equity provides better governance. However, companies that go private lose access to financing other than debt. The disappearance of listed companies is a warning against excessive regulation discouraging listing companies.